Showing posts with label CDO. Show all posts
Showing posts with label CDO. Show all posts

Monday, September 22, 2008


We are stunned to learn that banking and financial market regulators are considering using taxpayer funds to finance the creation of a separate entity to hold "toxic" financial instruments. This is a dangerous suggestion that will not solve the problem. At best, this is akin to moving a fire from, say, your living room to your dining room. At either location, the fire will continue to grow. The proposed separate entity simply provides more oxygen to the fire, wherever it is.

We will be spending all of our reserves:
1. to purchase a set of financial instruments with limited information on what, exactly, we are buying,
2. to purchase a set of financial instruments with limited value,
3. to purchase a set of financial instruments with unlimited risk,
4. to purchase a set of financial instruments with virtually no information on how long we will have to hold them to "turn a profit." (Note that these contracts will never turn a profit. They are not designed to...) and,
5. to do all of this under severe time pressure.

Thus, the plan has the added disadvantage of eventually forcing the US Government to follow Wall Street into bankruptcy. A spectacularly bad deal.

These toxic instruments were created not to stabilize markets, since clearly, they have failed to do so. These newer derivative contracts and products were created to evade regulatory safeguards and to maximize commission revenue. They did so by being opaque and hard, if not impossible, to value. Few serve any truly useful function. We note that, for 100 years, standardized futures contracts and options (derivatives) have been used to stabilize markets. We would not think of buying all outstanding futures contracts traded on the Chicago Board of Trade. Why are we being asked to do so for a private exchange run by a group of firms in New York? This confirms what we wrote on April 3rd: With the development of toxic (derivative and subprime lending) financial products, the relationship between investment banks and the economy has turned parasitic. Using all of the reserves at the Federal Reserve to bail these firms out would be a foolish waste of money.

To protect the public and the markets, these newer derivative contracts should be extinguished. To put the fire out, put the fire out. Again, they serve no purpose but to generate revenue for brokerage firms and investment banks. Even in that, over the long term, they failed. The best way to extinguish these instruments is to create a database showing the transaction chain (seller, buyer, intermediary) for each and every financial derivative contract, something the State of NY is moving to do with credit default swaps. We note that this is the role of an exchange. The transaction database should includes information on prices and commissions paid. Instruments should be reviewed one-by-one by a panel of objective experts to determine economic value and utility. Legal contracts supporting those without either should be vacated immediately by the SEC, operating with the consent of the US Congress. Note that we are not opposed to the creation of an entity holding assets backed by real property or loans.

Finally, there should be a 14 day "cooling off" period before anything is done. If this means forcing banks to lend (short term) to corporations, so be it. This is cheaper (and better) than the alternative, spending $700 billion at once.

We are deeply concerned.